MARCH 15, 1984
The Trust Industry: Meeting the Competitive Challenge
AN ADDRESS BY Alan R. Marchment, F.C.A. CHAIRMAN, TRUST COMPANIES ASSOCIATION OF CANADA, CHAIRMAN, PRESIDENT AND CHIEF EXECUTIVE OFFICER GUARANTY TRUST COMPANY OF CANADA
CHAIRMAN The President, Douglas L. Derry, F.C.A.
Distinguished Past Presidents, ladies and gentlemen: The last several years have produced, at a dynamic pace, increasing innovation and variety in services provided within the financial sector. As a response to the varied and complex needs of consumers, this is a positive commentary on the functioning of this part of our economy. However, as these needs and opportunities develop, there is increasing frustration and disagreement among our traditional "four financial pillars" - banks, trust companies, insurance companies, and investment firms - frustration over legislative lethargy and disagreement over their respective roles, as each group jockeys for position in an environment of uncertainty and as distinctions become increasingly blurred due to new areas of opportunity overlapping the traditional areas of responsibility.
One need only look at a few recent developments:
- We are seeing banks moving into traditional investment industry territory with the offering and promotion of securities transactions through discount brokers, and as more recently announced by one bank, into the field of self-directed Registered Retirement Savings Plans - until now the preserve of trust companies and investment firms.
- Trust companies have found that a traditional strength in mortgage lending was eroded after banks were permitted more fully into that area in 1967, and they have been unsuccessfully lobbying ever since to have their sharply restricted lending activities broadened in order that they may compete on a more uniform basis.
- Life and health insurance companies are not satisfied with selling only protection. They want to expand into new areas such as trustee services, loans to clients, equipment leasing, and the issuance and redemption of government bonds.
- Of course, investment companies are not sleeping either. Some of them are going into banking-type services, including the sale of no-load funds specializing in money market instruments.
So each group is attempting to expand its sphere of activities, while legislation remains outdated and little evidence exists of its getting early attention. Although the Bank Act was recently revised, trust and loan company legislation, after some seventy years of patching, seems doomed to continued uncertainty, while hope by insurance companies for expanded powers after some fifty years may only be a fond dream. The appointment in January by the Minister of Finance of an advisory committee on financial institutions to study the whole system is felt by many to be just another way of avoiding the issues until after another election.
In the midst of these quickly changing times, we are pleased to be addressed by the chief spokesman of one of these groups. Alan Marchment graduated in Philosophy from the University of Toronto and qualified as a Chartered Accountant in 1955. Over the next ten years, he held increasingly senior positions in industry, first in Toronto and then in Los Angeles and Paris, prior to joining Eaton's, where he rose to the position of Vice-President, Finance. In 1973, Mr. Marchment joined Guaranty Trust Company as President and a director, becoming Chief Executive Officer in 1975 and Chairman in 1979. Since 1977, he has also been a director of Traders Group Limited, becoming Chairman and Chief Executive Officer in 1979.
Mr. Marchment has a wide variety of interests and at various times has served as Chairman or President of the Toronto Symphony, the University of Guelph, The National Club, the Gage Research Institute, and the Hincks Treatment Centre. He has also served on the boards of the Toronto Western Hospital and the Canadian Institute of Chartered Accountants. In addition to his responsibilities as Chairman of the Trust Companies Association, Mr. Marchment is currently Chairman of the Toronto Symphony Foundation and is a member of the Council of the Board of Trade of Metropolitan Toronto. Most recently, Mr. Marchment has become a director of Metro International Caravan.
Alan Marchment has demonstrated his broad interests and abilities in many areas. I am pleased to welcome him today to address us on "The Trust Industry: Meeting the Competitive Challenge."
Mr. Chairman, fellow members, distinguished guests, ladies and gentlemen: It is an honour for me to address you today. I have selected as my topic, "The Trust Industry: Meeting the Competitive Challenge." Right now, the market for financial services is undergoing substantial change, which is both disruptive and frustrating for the trust industry. Competition is intense across a wide range of services among the giant chartered banks, the new foreign banks, the sizable insurance companies, the brokerage business, the credit unions, and the trust companies. Everyone, it seems, is scrambling to harvest some of the golden apples in other's historic orchards. That's fine, if you believe in unfettered competition without the indignant accusation of unfair trespass. But there's one problem. The government is, if you wish, the estate manager deciding who can enter the orchards, and how many apples they can pick. That's fine too, if everyone has a fair chance. But everyone does not.
The Canadian-owned trust industry is being excluded from the orchard, from doing for Canadians what it is quite competent to do - provide a wide range of consumer and business financial services. The main stumbling block is the continued postponement of new federal legislation.
What I would like to do today is provide some historic background on the Canadian trust industry and its importance to the nation, discuss the rapidly changing market place for financial services, and focus on the need for new legislation that will permit the trust industry to meet the competitive challenge.
First, let me put the industry in historical perspective. The origin of Canadian trust companies as both trustees and financial intermediaries stems from two different roots. Prior to Confederation, only an individual could act as a trustee, since a corporation was deemed to have neither a conscience nor a sense of personal responsibility. In the late nineteenth century, however, the growth of commerce and wealth led to the need for professional organizations with a perpetual capacity to provide diversified services as executors, trustees, and agents.
Corporate trustees were first permitted in Ontario in 1872, although the first trust company did not become operational until the 1880s. Comprehensive legislation for the incorporation of trust companies was enacted in 1897.
Today, trust companies are the only corporate entities in Canada which are empowered to act as trustees in managing the assets of personal estates, pension and deferred benefit plans. Trust companies also act as corporate trustees for bond and debenture issues, and as stock transfer agents. These services form the fiduciary and agency side of our business.
We are required to act with fidelity and diligence. And we do. While there have been scandals involving a very few companies, it is a firm fact that the Canadian trust industry as a whole has proven time and again that it has earned the confidence of Canadian individuals and corporations. We are, then, a responsible industry with a long track record of dedicated service to Canadians as trustees. On the financial intermediary side, trust companies can trace their roots to building societies, which were established in the last century to help the early settlers raise capital to construct houses. Later, they evolved into loan companies.
Significantly, trust companies are not restricted solely to the trustee business. The industry has quite naturally expanded into financial intermediary, or deposit, services. In fact, its role in the financial intermediary field was formally recognized as long ago as 1912, when Ontario merged its Trust Companies Act and Loan Corporations Act into a single statute. That 1912 legislation enabled the industry to accept money as trustees for investment and, in 1921, to accept deposits for investment as trust funds. Later, we were allowed to issue guaranteed investment deposits with fixed rates of interest.
Today, our financial intermediary services involve the raising of deposits through guaranteed investment certificates, savings and chequing accounts, and demand deposits. In this respect, we act much like a chartered bank.
From the beginning, we were - and continue to be - closely regulated by governments in terms of our capitalization, the protection and management of clients' assets, and our borrowing and investment powers. We are required to invest twothirds of deposits in residential mortgages and other quality assets, such as government bonds and securities. We are severely restricted in doing much else, especially in making consumer and commercial loans. We have lower debt-equity ratios than the banks, and we are required to maintain significant liquidity reserves. Because of our mandated involvement in residential mortgages, many trust companies have branched out further in real estate sales and management. So, as you can see, the industry has had an extensive, steady, and natural evolution from its original trustee base into deposit services and real estate services.
In recent years, the industry's estate business has generally become less profitable. It is complex and labour-intensive, demanding considerable professional expertise. Our response to this has been increased education to upgrade staff skills and the installation of sophisticated computer systems to further enhance productivity and profitability. Because of our fiduciary responsibilities, we impose on ourselves high standards of professional conduct. We have a special faith with the public. Besides being a responsible industry, we are an important one that is essential to the financial fabric of this country.
In 1982, there were seventy-seven trust companies in Canada. They administered assets exceeding $128 billion, consisting of $40 billion in intermediary assets and $88 billion in estates, trusts, and agency funds. These figures suggest we are big. But size is relative. In fact, the intermediary assets of the entire trust industry are less than those of Canada's fourthlargest chartered bank. We are, therefore, hardly a threat to the established banking order, although we are flattered that many bankers seem to think we are. We are also Canadian-owned and a major employer, with a work force exceeding thirty-six thousand people in our trust, intermediary, and real estate operations from coast to coast.
This background on trust companies as a substantial industry brings me to the pivotal issue: meeting the competitive challenge. Being competitive in any business means keeping pace with - and bringing about - change. In recent years, the whole field of financial services has undergone dramatic alterations.
The lines are becoming increasingly blurred among the so-called "four pillars" in the financial services field - the banks, trust companies, insurance companies, and investment dealers - as a result of consumer demands.
Beginning with the 1954 Bank Act revisions, the chartered banks, with their enormous resources, have expanded massively into new terrain. Today, they have 68 per cent of the consumer lending market and a 22 per cent share of the residential mortgage market. They are now making inroads into the registered retirement savings and brokerage businesses. The banks have responded to the underlying demographics - the coming of age of the post-Second-World-War "baby boom" generation. The foreign banks have established themselves as a new source of commercial loans, and seek further room to expand. The insurance industry, another sizable entity, is seeking fiduciary powers to compete directly with the trust industry, as well as to enter the intermediary and brokerage fields. Similarly, the trust industry wants to expand its investment and lending powers to consumers and business in order to meet growing and changing demands in Canada for financial services. Credit unions want to expand their savings and loans services, and brokers want more flexibility in offering various financial services. All of this is good, if it results in more competition of benefit to the Canadian economy, and if all sectors of the financial community are given a fair chance to compete with each other on equitable terms.
In fact, modern technology - such as telecommunications systems, credit card systems, electronic funds transfer systems, and on-line data processing - makes it feasible to create an integrated financial services supermarket that not only bridges traditional sector boundaries but international boundaries as well. Marshall McLuhan's global village is very much an electronically wired reality in the financial field. Financial supermarkets already exist in the United States. They would exist in Canada too, if natural market forces were not impeded by the overlay of strict federal and provincial regulations.
To be a player in the Canadian marketplace, you need a score card and a set of rules issued and approved by governments. In 1981, the chartered banks and foreign banks received the necessary legislation to permit them to expand their services and market shares. It is interesting that the banks have their charters reviewed and expanded every ten years, while federal trust company legislation has not received a similar overhaul in seventy years.
The trust industry has been waiting since 1976 for new federal legislation, which exists in draft form. It was introduced two years ago, only to be withdrawn and delayed again. Late last year, the finance minister advised that legislation will not be introduced until after the next election. That means we have been benched as a competitive player until probably 1986. That, for us, represents a lost decade of potential growth. We think this is unfair not only to us but to Canadian individuals and firms who want to do business with us.
There is no dispute that greater and more equitable competition among financial intermediaries is in the best interests of Canada's economic future. Nor is there any dispute that trust companies have the experience and competence to expand their banking services.
Unfortunately - and this is the nub of our competitive difficulty - our industry is handcuffed to an outdated investment notion. As I mentioned earlier, we are required to invest the deposits we raise in certain assets, mainly residential mortgages. Historically, trust companies were the principal source of residential mortgage funds among private lenders.
In recent years, this has changed. The 1967 Bank Act empowered chartered banks to make uninsured residential mortgage loans. With seven thousand branches across Canada, they had the resources to move fast and deeply into the business. Today, the banks account for about half of all new and renewed residential mortgage loans. They have virtually taken over a market traditionally serviced by trust companies, not because they are any better at making mortgage loans, but because of their sheer size.
Our competitive challenge is made more difficult because the rate of increase in the residential mortgage market has slowed down considerably. Government studies predict further decline throughout the remainder of this century because of the greying of Canada. Consequently, we find ourselves in the position of competing with the banks and others in a shrinking market. At the same time, various forecasts indicate a growing need for investment funds by business firms.
We are, therefore, asking the federal government to do two things: first, to recognize a simple market reality beyond our control - that the opportunities for investing in residential mortgages are vanishing for demographic and other reasons.
We have recommended that the requirement that we must invest in residential mortgages and other quality assets be reduced from the present two-thirds level to a more acceptable 50 per cent level. Second, we are asking that we be granted broadened investment opportunities, specifically in consumer and commercial loans.
Currently, a trust company is allowed to make consumer and commercial loans not secured by real estate up to a maximum of 7 per cent of their book value of assets, under the so-called "basket clause." Our industry's record of credit losses is far superior to that of the chartered banks. In 1983, the chartered banks' loss ratio was approximately 1.22 per cent, versus only 0.22 per cent for trust companies. Trust companies have limited, if any, exposure to foreign credit risks. Our performance is also better in terms of non-productive loans. This is despite the fact that we must take our losses in the years they occur, while the chartered banks are allowed to average their losses over five years. There is, therefore, no question about our competence as a commercial and consumer lender.
What we are seeking is permission to engage in commercial lending to all types and sizes of Canadian business enterprises, within certain bounds. We have recommended that commercial lending be allowed to at least 15 per cent of the book value of total assets for short-term working-capital-type loans, but that there be no restriction on making term loans, or engaging in syndicated loans and financial leasing. This request certainly poses no threat to the banks. How could they possibly be frightened by new competition from an industry which has total intermediary assets of only $40 billion, compared with their $350 billion? How could they possibly feel threatened by an entire industry which, under our proposal, would have the potential to make only $5.1 billion worth of commercial loans, compared with their already-existing $74 billion business loan portfolio? In terms of relative size, it would be like the United States fearing a takeover of its economy by Canada.
Besides, it should be remembered that the banks have tremendous scope for growth. They are empowered to do virtually anything they choose, except those things which are specifically prohibited. For trust companies, it's the other way around: we can only do what is specified in legislation. Furthermore, our assets and liabilities are more extensively and completely regulated than those of the banks.
Nor does our reasonable proposal threaten the new foreign banks. They already have the right to average outstanding total domestic assets of 8 per cent of total domestic bank assets. This means they can lend Canadian firms nearly $17 billion - more than three times the level we are requesting. Now, they are asking for even greater commercial lending powers. We think the foreign banks should compete in the commercial lending business. What strikes us as totally unfair is that the foreign banks are being given a long head start in staking out a generous market share while we, a Canadian-owned industry, are left in the starting blocks, because the government hasn't got time to deal with our legislation until after the next election.
We also seek the opportunity to diversify our asset mix into the consumer loan field, where we have considerable experience and an exemplary track record. Canadians expect trust companies to have the ability to meet their financial needs. They consider us as a banking alternative on both the deposit and the loan side. It makes eminent sense that legislation now acknowledge this market reality too.
All of this would, belatedly, put us on a more equal footing with banks - although one cannot resist noting the difference in shoe size between the five banking Goliaths and the dozens of little Davids in the trust industry.
Other concerns have been raised about the viability of the trust industry in the wake of the Crown Trust-Greymac-Seaway Trust affair. That unfortunate situation in no way indicates the reputation and strength of the industry, anymore than troubles within a small bank would reflect adversely on the banking community.
The Ontario government has made a considerable effort to study the trust industry. Some of its conclusions are quite revealing. It rejects a total restructuring of the industry as well as imposing ownership restrictions on trust companies, recommending instead a need to clarify and toughen conflict-ofinterest rules and management standards. Specifically, the White Paper says:
The possibility of a majority shareholder putting personal interest ahead of fiduciary responsibilities can probably be more effectively dealt with by specific conflict of interest amendments rather than by absolute limitations of ownership.
The Ontario study points out that if a 10 per cent ownership restriction were imposed on the dozen major trust companies, it would necessitate raising up to $3 billion in capital to accomplish a change that would almost certainly weaken, rather than strengthen, the underlying capital bases of the firms affected.
The issue, then, is not ownership but resolving conflicts of interest. An interesting point is that trust companies are prohibited from making loans to their directors and officers, or their affiliates. If I want to borrow money, I have to visit a bank. A bank director, however, can borrow from his own bank for personal and business purposes.
Essentially, the Ontario White Paper recommends that the performance of trust companies, and the resolution of conflicts of interest, can be achieved by enhancing the powers and accountability of external advisers, lawyers, auditors, and valuators. It also proposes that regulations be established for ensuring that liabilities and assets are properly matched to preserve financial stability. The Ontario White Paper supports the necessity for greater competition in providing individuals and businesses with needed financial services. It believes we should be given more scope to make commercial loans with prescribed limits on loans to any one borrower. The White Paper states:
Provision should be made to broaden and extend investment and lending powers as capital base, borrowing multiples, and financial and other resources are expanded and to give maximum investment powers to trust corporations with proven resources, management, and experience.
The competitive challenge now is to enlarge the scope of services we can safely and competently provide to individuals, families, and businesses. The obstacle for the trust industry - and for the insurance industry as well - is that government legislation is woefully out of step with the realities of a rapidly changing market place. It is imperative that the federal government give priority to passage of reformed legislation that will enable us to service Canadians better, and that will set the tone and direction for compatible provincial legislation. That is all we ask - enlightened legislation that gives us the chance to compete fairly, squarely, and openly for the benefit of Canadian consumers and business enterprises. Thank you.
The appreciation of the audience was expressed by Henry N. R. Jackman, a Past President of The Empire Club of Canada.